Where do you go as interest rates fall?

Due to the increase in interest rates over the last couple of years, cash has been a relatively attractive investment however as rates on deposits have started to fall, more investors are again turning to investment portfolios to make their money work harder.

But as the returns fall on cash accounts and short-dated bonds, where can investors turn?

Don’t fall into the reinvestment risk trap
As fixed terms come to an end, many institutions reoffer new terms but with lower rates. After becoming used to decades of very low (or no) interest being offered on savings, it is still easy to find any savings rate above zero attractive – even though we know this is well behind inflation, so the value is going backwards in real terms.

With cash looking less attractive as a long-term option, savvy savers are looking back to the markets to get their money working for the longer term.

But aren’t investments ‘risky’?
Risk is misunderstood and is often confused with volatility. Risk can be more accurately defined as the “chance of permanent loss of capital”, whereas volatility is simply the degree to which investments move up and down.

Although many feel shares in companies are a “risky” investment, if we look back over the past several decades, we can see the chance of permeant loss is very small when investing in high quality “blue-chip” companies such as Apple, Nestle or BP etc.

Volatility is what scares most investors- the ups and the downs. But putting this into perspective, most of us own a home and are aware of what the property market does, it also goes up and down. But unlike with an investment, you don’t have a ticker on your post box telling you the daily price, so you don’t see the volatility and therefore, do not “feel” the risk.

What about returns?
The return you achieve from your portfolio is determined primarily by the composition of the underlying portfolio i.e. the split between shares, bonds and other assets such as property and commodities etc.

Despite the doom and gloom in the world at the moment, markets have done very well over 2023, and whilst cash has offered attractive rates of 5-6%, the S&P500 achieved 24% over 2023.

Longer term returns 
Whilst the returns achieved in 2023 are not guaranteed to continue, if we look back at longer term records, figures from Credit Suisse show that over a 123-year period starting in 1900, shares in developed equity markets have generated returns at 5.1% above inflation and emerging equity markets have achieved 3.8% over inflation.

The Credit Suisse figures also show that shares have outperformed cash (and bonds) in every one of the 21 countries their data covered over that 123-year period. This is quite remarkable given this period covers two world wars, two global pandemics, the great depression, dot-com bubble, and the global financial crisis!

So, shares could be considered lower risk than cash or property because of their proven ability to keep pace with inflation over time and therefore protect your money in real terms.

What steps can you take to maximise your annual investment returns?
The return you receive as investor will be determined by a range of factors and there are certain steps you can take to increase your return expectations:

Select the right funds: The difference in fund performance can be startling e.g. in a recent analysis we carried out of the US equity sector, the top performing funds was up 67% whereas the worst was down -25%!

Review regularly: Whilst a buy and hold approach is one of the most popular strategies for investors, reviews are essential. Not only to ensure your risk level, asset mix and diversification are in line with your objectives, but also to ensure your portfolio remains relevant. Looking over a 40-year period at the FTSE 100, only 24 companies (or arguably 35 including mergers and acquisitions) are still in the index since 1984.

Minimise fees: Ensure you have a clear view of what you are paying. Minimising fund management and advisory costs puts more money back into your portfolio and leads to better net performance. Ensure you check and read all paperwork when making any investments, or even better, get a professional second opinion on value.

Minimise tax: With interest, dividends and capital gains tax at 28% for standard residents (note, 28% capital gains tax does still apply to Non-Habitual Residents), tax is one of the biggest eroders of investment return. So, give some thought to how you hold your portfolio and take advantage of the different tax “wrappers” available to Portuguese tax residents, but keep an eye on fees and only seek advice from qualified advisers.